Supply may have been plentiful in the primary market in the first quarter but new regulations, increased capital charges for banks’ staple trading activities and concerns over a return to the volatility seen last year have all conspired to make the trading environment a challenging one.

Human towers of strength: traders on secondary desks can help their syndicate colleagues

Raphael Robelin, senior portfolio manager with asset manager BlueBay, says different banks take different approaches to the way they support deals after pricing. He hails the structure at BNP Paribas, where a trader is dedicated to supporting bonds led by his syndicate colleagues, but not everyone believes this approach is necessary.

Sean Taor, head of debt capital markets, Europe, at Royal Bank of Canada Capital Markets, said banks without this arrangement are not necessarily making a statement about their approach to deals they have brought to market.

“We take the view that we will see more flow in a deal, and therefore are more able to support a new issue, if it is traded by the desk that is right at the heart of flows within the sector, and that is the secondary desk. It works because our secondary traders share the same values, and are as incentivised to do the best job they can on the deals the bank has led as they would be if they sat elsewhere. That is not always the case at other firms,” he said.

Some investors have reported incidents of traders, separated from their syndicate colleagues by Chinese walls, acting against deals led by their own banks but Taor said this is not something he recognises.

“Debt capital markets are central to our fixed-income platform and our secondary traders work very hard to support that primary business. They work with the primary desk, not against it.”

But Frederic Ponzo, managing partner of capital markets consultancy GreySpark, said a secondary business that is successful in its own right is not necessarily a boon to recent issuance led by its bank. He said: “A stronger secondary market franchise actually makes you less inclined to support the issuance through secondary trading, because the traders will have a bigger fee than the syndication fee.

Banks that consider themselves dealmakers and are mainly interbank players will be less fussed if they make losses on the secondary trading book.”

However it is calibrated, secondary market support is an important complement for a new issues business, but increased costs are increasing pressure on banks to cut back.

Ponzo said: “In order to support a primary market franchise you need to have strong secondary market activity: you cannot just do primary and not be present on the secondary side. But there is a lot of pressure on secondary trading desks to cut inventory and cycle through it relatively quickly, which means there is a lot less appetite and ability to take risk.”

Capital charges under Basel 2.5, which already applies, and Basel 3, which is due to be phased in from next year, mean it is already becoming more expensive to make markets. Ponzo added: “This means that some secondary market activities are coming close to not being economically viable. As a result the traders are retrenching.”

Will Rhode, director of fixed-income research at Tabb Group, a research firm, believes the effects will be felt beyond the trading environment and inhibit new issuance. He notes that the boom in new deals has in large part been confined to the biggest investment-grade names in large size and at the shortest durations, which traders find the easiest to turn over quickly.

Rhode said: “For SMEs, coupons are going to be driven higher as a result of lack of marketmaking appetite to warehouse their bonds and thus the bond market will be removed from them as a funding tool.

“We’re going to see a complete structural overhaul. Even though it appears as if corporates are diversifying away from banks in their borrowing, the reality is that only a select few have access to the bond market. Banks are already pulling back from marketmaking. Balance sheet constraints mean they are not incentivised to provide liquidity. Issuance will stall as a result.”

While sellside bankers say Rhode’s argument is logical, they believe issuance will continue for all types of issuer regardless of trading conditions because there are increasingly few alternatives.

RBC’s Taor said: “That takes the market in isolation, and in isolation that dynamic certainly makes it harder, or potentially more costly, to issue. However, the financing alternatives to bond issuance are also less available, so I’d question that assumption.”

Inventory is declining but some bankers report that their cash trading volumes are unaffected. Brett Tejpaul, head of credit sales and head of distribution for UK and Ireland at Barclays, sees a lot more secondary business in the current market than previously.

“Volumes in cash are up 20% to 30% on average from last year, reflecting the fact that many investors have returned to the market as the volatility seen in the second half of the year has subsided for now,” he said.

But while primary business is booming, its nature means there is a ceiling on trading activity.

The European Central Bank’s long-term refinancing operation has prompted issuance and increased trading, but the facility’s three-year duration acts as a stop. Many of the recent bonds, especially from banks, have been at maturities of three years or below and by their nature, they are liquid for less time than bonds of five, seven or 10 years’ duration.

Tejpaul believes growing risk appetite from investors also inhibits trading. New bonds at the beginning of the year came with concessions but improving sentiment has removed the necessity for them.